Trailer fees and the future of ETFs

As ETF sales have grown in recent years, mutual fund sales have lagged. There is no direct connection—investors have been abandoning stocks and bonds for real estate. Yet, the rise in ETF sales does indicate that not all investors have exited the securities markets. They’ve shifted to better beta.

Why better beta? Perhaps there is an underlying factor that connects the two: advice and advisors.

This is worth some scrutiny. The Canadian Securities Administrators have published a paper on mutual fund fees that includes advisor compensation. In their line of sight are trailer commissions. Australia and the U.K. are abolishing trailer commissions.

Advisors have to be paid for their services. No one disputes that. But what do they give to the client? Advice, or access to a transaction? It’s a perennial question.

The 30% annual growth rate in ETF sales in Canada puts that discussion in the headlights. Vanguard, famous for its low-fee appeal to direct investors in the U.S.—which created a halo effect elsewhere—finally entered the Canadian market about a year ago. But it’s not just do-it-yourself investors who are fuelling Vanguard’s sales in Canada. About 30% of its ETFs are bought through financial advisors.

That has a lot to do with the shifting landscape of advisor compensation, since Vanguard doesn’t provide trailing commissions. Very few ETFs do.

So if advisor compensation didn’t promote ETF growth, what did?

What was important in Vanguard’s decision finally to come to Canada was the growing importance of fee-based advisors. They make up 20% of the market in Canada—but it’s closer to 60% in the U.S., says Vanguard’s Canadian managing director, Atul Tiwari.

Are mutual funds dead? No. Not the good ones. But access to markets through mutual funds—with attendant trailer fees—is a fading model for financial planners. Clients will pay for transparent beta—and transparent advice.